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Officials Relax Market-Timing Penalty Rules

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Mutual funds will have a choice about whether they must impose redemption fees on speculators who use abusive trading strategies.[@@]

The U.S. Securities and Exchange Commission today approved a final rule that gives mutual funds more flexibility than it had earlier proposed in dealing with brokerages and pension funds it suspects of market timing.

The insurance industry praised the change in the regulation, saying the final rule on market-timing redemption fees will keep holders of variable annuities, holders of variable life policies and participants in 401(k) plans on a level playing field with investors in mutual funds.

The original SEC proposal, published in February 2003, would have required that mutual funds impose mandatory fees on market timers, or speculators who try to use rapid trades to take advantage of inefficiencies in the spread of share price data. The commission said its rule would allow, but not require, funds to impose such penalties.

At the same time, the SEC said it does plan to revisit the issue.

Paul Roye, the director of the SEC’s Division of Investment Management, said today at the commission meeting that the agency will seek further comment on steps it might take to “encourage intermediaries that sell fund shares to implement a fund’s redemption fee policies.”

The final regulation requires mutual funds to sign written agreements with intermediary firms, such as brokerages and pension plan administrators, which handle the bulk of trading in fund shares.

The pacts will require the intermediaries to supply the funds with identity and transaction information about certain investors if requested.

The new rule allows the mutual fund to tell the intermediary to restrict an investor’s trading if it suspects an investor of engaging in market timing. But the rule does not require any sanctions, as the earlier rule did.

In effect, neither variable products nor retirement savings plans will be required to combat abusive market-timing through mandatory redemption fees, says Carl Wilkerson, a vice president and chief counsel for securities and litigation at the American Council of Life Insurers, Washington.

Wilkerson says the SEC final rule in many ways reflects ACLI’s comments to the agency about the topic.

“Mandatory redemption fees is one of several market-timing controls,” Wilkerson says. He says mandatory redemption fees “do not work seamlessly across all product platforms, such as pension plans funded by variable annuities.” As a result, he adds, “mandatory redemption fees could have impaired competition, which ultimately would harm people saving for the long term.”

Wilkerson says the ACLI also suggested amendments to the disclosure requirements that would give portfolio managers the ability to address rapidly evolving market-timing techniques.

However, noting that enhanced disclosure requirements alone will not fully control market-timing abuses, ACLI advocates “fair value pricing.” Fair value pricing is a system for up-to-the minute portfolio valuation based on statistical modeling and regression analysis. This method cuts down on market timers’ opportunities to profit from pricing inefficiencies caused by factors such as differences in time zones and thin trading volumes.

“The SEC ruled wisely on this issue,” Wilkerson says. “Their decision will help fight fraud while ensuring nobody planning for the future is put at a disadvantage compared to another investor.”

In related news: The SEC says an independent consultant, Peter Tufano, has determined that past market timing and excessive short-term trading at Putnam Investments, Boston, a unit of Marsh & McLennan Companies Inc., New York, cost Putnam investors about $4.4 million in direct costs.

Investors’ rush to get out of Putnam funds after disclosure of the market-timing and short-term trading problems cost Putnam shareholders another $48.5 million, Tufano found.

Putnam has agreed to pay $50 million in civil penalties and says it will compensate shareholders for all of the costs that Tufano discovers in connection with the market-timing and short-term trading problems, according to SEC officials.

Allison Bell added information to this report.


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